The Case for Open-Market Purchases in a Liquidity Trap

62 Pages Posted: 20 Jul 2004

See all articles by Alan J. Auerbach

Alan J. Auerbach

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Maurice Obstfeld

University of California, Berkeley - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2004

Abstract

Prevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open-market operations ineffective for achieving macroeconomic stabilization goals. We show that even were this the case, there remains a powerful argument for large-scale open-market operations as a fiscal policy tool. As we also demonstrate, however, this same reasoning implies that open-market operations will be beneficial for stabilization as well, even when the economy is expected to remain mired in a liquidity trap for some time. Thus, the microeconomic fiscal benefits of open-market operations in a liquidity trap go hand in hand with standard macroeconomic objectives. Motivated by Japan's recent economic experience, we use a dynamic general-equilibrium model to assess the welfare impact of open-market operations for an economy in Japan's predicament. We argue that Japan can achieve a substantial welfare improvement through large open-market purchases of domestic government debt.

Keywords: Liquidity trap, zero bound, Japan

JEL Classification: E43, E52, E63

Suggested Citation

Auerbach, Alan Jeffrey and Obstfeld, Maurice, The Case for Open-Market Purchases in a Liquidity Trap (June 2004). CEPR Discussion Paper No. 4447. Available at SSRN: https://ssrn.com/abstract=566881

Alan Jeffrey Auerbach

University of California, Berkeley - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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Maurice Obstfeld (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-643-9646 (Phone)
510-642-6615 (Fax)

HOME PAGE: http://emlab.berkeley.edu/users/obstfeld/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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